Biggest Shift Since 2016

The Fed formalized its dovish turn, that it started making after its rate hike in December, in its January statement and press conference. In shifting guidance and policy in the dovish direction, the Fed resumed its dependency on the stock market that it exhibited under Bernanke and Yellen. In 2018, investors thought Powell was different because stocks fell on FOMC days 7 straight times. Many Austrian economists praised Powell for being different as they feel rates need to be higher. However, Powell and the rest of the FOMC eventually blinked late last year after the S&P 500 fell 20%. Powell allowed the stock market to fall more than his predecessors, but he eventually gave in.

To be clear, monetary policy is not the only factor that affects stocks. At the end of 2018, investors were worried about the global economic slowdown. Instead of calming the markets, the Fed raised rates in December. Lowering guidance to 2 hikes in 2019, wasn’t enough to change sentiment. Powell’s statement that the balance sheet unwind was on autopilot made traders think he was out of touch.

Stocks Have Rebounded, But The Fed Formalized Its Dovishness

The interesting aspect to the Fed’s January statements and press conference is that the S&P 500 had rallied sharply in 2019. If you assumed the Fed would react to stock market action, you may have considered the possibility that the Fed would be neutral since the sentiment tide has turned. However, the Fed went all in on the dovishness as it still was reacting to the December decline.

As you can see from the chart below, the number of hikes expected in 2019 and the S&P 500 were correlated in 2018.

Is this Fed meeting a game changer for EM? Relative to market pricing - flat for 2019 and one cut in 2020 - no. But what is a game changer is how much of the narrative unceremoniously went overboard: (i) tightening bias; (ii) QT; (iii) risk assessment (balanced); (iii) "patient." pic.twitter.com/jdvOMYQyXR

The expectation for 2 hikes in 2019 and the guidance for 3 hikes, were partially why stocks topped in September. Stocks then bottomed when rate cuts in the next 2 years were priced in and the Fed moved dovishly. By making a dovish statement in January, the Fed is allowing stocks to rebound without having the natural inhibitor that is the expectation for more rate hikes. This explains why the S&P 500 increased 1.55% on Wednesday following the FOMC.